India is burdened by its love for gold. Our position as the one of world’s top gold consumers has become a cross round our neck. But need it be so? Not if China’s success is any indicator. China has single-handedly tilted the balance of power in world gold market from West to East.
China is the most important player in the world gold market. It accumulates gold for its monetary value and in anticipation of a new monetary system. In 2013, China emerged as the world’s largest producer and consumer of gold. In 2014, it effectively sealed this dominance with a unique mix of market-savvy strategies.
The first one was to encourage its people to start holding gold. In 1950, communist China prohibited private ownership of bullion and put the gold industry under state control. Fifty years later the People’s Bank of China abandoned its monopoly on the purchase, allocation and pricing of gold. In 2004, for the first time since 1950, private persons were permitted to own and trade gold.
Gold demand in China could not have flourished as it has without the blessing of the authorities. The World Gold Council’s recent report, China Gold Market: Progress and Prospects, says, “China’s leaders regard the public’s gold holdings as part of the nation’s reserves that could be called upon in an emergency”.
China should accumulate 8,500 tonnes in official gold reserves, more than the US, according to Song Xin, President of the China Gold Association, General Manager of the China National Gold Group Corporation and Party Secretary. Investment in gold has benefited also from the limited selection of alternative forms of savings in China. Today China is the world’s largest market for gold bars.
This demand will only accelerate in future. And it will be a fundamental factor supporting the flow of gold from West to East.
The second aspect of the strategy is to consolidate its pole position as largest producer of gold in the world. Gold’s big three (South Africa, the United States, and Australia) were the big three for a long time. In 2007, China overtook them. Gold production over the last decade has more than doubled. Interestingly, the major source of China’s big increase in production is thousands of new smaller-scale mines. With labour and materials cheap, coupled with a generally lax regulatory system, it’s not too difficult to develop a mining operation.
Foreign expansion will be a growing priority for Chinese mining companies. Australia, Peru, Canada, Colombia and the United States are all attractive destinations for investment. Growing political ties between China and Africa will also spur the development of projects in Ghana and Congo. China’s central bank recently circulated a draft plan to ease restrictions on gold imports by local miners.
The third strategy is the internationalization of its gold market. Until recently, China’s gold market was closed. Now Chinese regulators are pushing to open up the country’s gold trade and lure foreign investors as part of its broader effort to link the mainland to global markets.
In September, it began offering international institutions access to yuan-denominated gold contracts in Shanghai’s free-trade zone through the International Board of SGE. The core business of the SGEI is to facilitate offshore gold trading in RMB. International customers can only deposit and withdrawal gold into and from IB Certified Vaults. This way international banks or investors trading IB physical products cannot drain physical gold from China mainland.
The first transactions were put through by a diverse group comprising HSBC, MKS (Switzerland), and the Chinese banks, ICBC, Bank of China and Bank of Communications. MKS is the Geneva headquartered precious metals trading group that also owns the large PAMP refinery in Switzerland. International bullion banks who have already announced their participation include ANZ, Standard Chartered and HSBC.
The presence of international refineries within SGEI trading should help it become a serious competitor to the gold price discovery in the London and New York markets. Since there is a lot of physical gold flowing through the exchange, price discovery is not just based on mostly unallocated gold as in London or paper gold as in New York.
There is also a larger game plan here. The world price of gold is dollar-priced and fluctuates with the US dollar. With the shaky status of the US dollar as the international reserve currency, China wants a new global currency setup. China has established a free trade yuan-denominated spot gold trading platform and a corresponding settlement system to increase China’s influence over global bullion prices.
The fourth, and related, development has been the closer relationship between Hong Kong, Singapore, and Shanghai gold markets. The Hong Kong-based Chinese Gold and Silver Society recently announced that they plan to build a massive new precious metals vault in Qianhai in Shenzhen. Its real purpose is to support a CGSE gold trading platform in Shenzhen and allow this new Shenzhen gold exchange to link up with the Shanghai Gold Exchange. Singapore has also introduced a physical gold contract this year in tandem with SGE, highlighting a push in the biggest consuming region to establish new price benchmarks as demand shifts east.
In the past, the world’s gold supply was channeled through London. Now a majority of refiners are in Switzerland and they are increasingly producing the 1 kg bar destined for Asia. With China opening up gold importing to bullion banks to channel gold directly to Shanghai, the supply through London is falling. So the ability of London to reflect a price that accounts for the bulk of global demand/supply is diminishing. Soon global gold suppliers and buyers will flock to do business in Shanghai rather than in London. In short, China is purposefully changing the structure of the world gold market.
China’s moves show that some governments believe gold will return to its role as an international currency. That gold can fill the vacuum created by the flailing ruble, dollar and the euro. India, as the other engine of the demand pull from the East, can equally easily take advantage of this shift. But that will only happen when we stop seeing gold as a burden, or as merely raw material for the jewellery sector, and fit it into our broader strategic and financial imperatives.